Military-Linked Chinese Auction House to IPO in Hong Kong

Various representatives bid for artworks during the Poly 2012 Spring Art Auction in Beijing on June 2, 2012. Source: AFP/GettyImages

Feb. 28 (Bloomberg) -- China Poly Group Corp., a state-owned conglomerate started by the country’s military 22 years
ago, is taking its arts and entertainment arm public in Hong
Kong as it seeks to compete with global auction houses.

Poly Culture Group Corp., which runs China’s largest
auction house and manages 31 theaters, and existing investors
raised $331 million after pricing an initial public offering at
the top end of a marketed range, a person with knowledge of the
matter said. Individual investors placed orders for more than
600 times the amount of stock available to them, according to
the person.

China eclipsed the U.S. to become the world’s largest art
market in 2011, according to a report by the European Art Fair,
only to lose its position back to the U.S. the following year as
auction houses grappled with non-payment by clients, art
forgeries and money laundering. Poly Culture’s Beijing auction
arm, which began holding sales in 2005, plans overseas expansion
to compete with Christie’s and Sotheby’s, in business for
centuries.

“There seems to be good demand from public investors,
leading to a large retail tranche,” said Philippe Espinasse,
former co-head of equity capital markets for Asia at Nomura
Holdings Inc. and author of “IPO: a Global Guide.” “However,
a number of buyers at auction in China end up not honoring their
commitments, and this could be a case of a good initial
performance and the shares then not doing well in the longer
run.”

Military Ties

Poly Culture and existing investors sold 77.8 million
shares at HK$33 apiece, the high end of a range that started at
HK$28.20, according to the person. The company’s “extensive
local business network” will enable it to enjoy economies of
scale, Poly Culture said in an IPO prospectus.

Net income fell to 386.3 million yuan ($63 million) in 2012
from 583.1 million yuan a year earlier and was 308.2 million
yuan in the first 10 months of 2013, according to the
prospectus. Shares are set to begin trading on March 6.

China Poly Group was set up in 1992 with the approval of
the State Council and the Central Military Commission. The
company is involved in arms trading, real estate, the arts and
minerals, and had total assets of 382.9 billion yuan at the end
of 2012, according to its website. The group started its arts
and entertainment subsidiary in 2000, according to the
prospectus.

’Negative Media’

Poly Culture’s military connections do not come without
risks, the company said in the prospectus. In February 2013, the
U.S. announced sanctions on a Poly defense unit, Poly
Technologies Inc., under the Iran, North Korea and Syria
Nonproliferation Act. Poly Technologies owned 32 percent of Poly
Culture at the time, according to the prospectus.

While the stake was transfered to the parent four months
later, Poly Culture said in the prospectus that it “may be
subject to negative media or investor attention.” After the
IPO, Poly Group is projected to maintain a 67 percent stake in
the listed company, according to the prospectus.

An operator at the Poly Group and Poly Technologies refused
to connect a call through to the Poly Group board secretary and
the company did not immediately responded to a fax seeking
comment on the U.S. sanctions.

Poly Group also cited the risks associated with non-payment
by the company’s mainland auction clients. The percentage of
recorded sales paid for in 2010 was 74 percent, falling to 55.5
percent in 2012 and 52.9 percent in the first 10 months of last
year, according to the prospectus.

Paying Customers

By comparison, Sotheby’s said in its 10-K filing with the
U.S. Securities and Exchange Commission that “historically,
canceled sales have not been material in relations to aggregate
hammer price of property sold at auction by Sotheby’s.”

Christie’s, which derives 72 percent of its Hong Kong
auction sales from mainland clients, has a non-payment rate of
about five percent, Simone Woo, acting head of Asia corporate
communications said.

One of the reasons Poly Culture started holding auctions in
Hong Kong in 2012 is that clients there pay on time, said Wang
Wenjia, a specialist in fine modern Chinese paintings and
calligraphy at the auction house.

“People who come to Hong Kong are more civilized buyers
and they respect the rules,” said Wang. “So we don’t have a
lot of clients who don’t pay.”

Money Laundering

Listing is also seen as a way of promoting the Poly brand
overseas as Christie’s and Sotheby’s are starting to compete
with them on their home turf.

“It will be 100 years before this company is going to be
on a footing with Sotheby’s and Christie’s,” said James
Hennessy, an art dealer in Hong Kong who formerly worked at
Christie’s. “I would say to investors, it’s way too early days,
stick with the proven players.”

Last September, Christie’s held its first mainland auction
in Shanghai, while Sotheby’s and its state-owned joint-venture
partner Beijing Gehua Cultural Development Group made its first
foray in Beijing in December.

The company prospectus also highlights risks related to art
forgery, unauthorized trading, money laundering and bribery.

“We cannot assure you that our internal control system in
relation to anti-money laundering and anti-corruption will be
effective,” according to the prospectus.

Another risk stems from Poly Culture’s practice of
advancing sellers as much as 30 percent of an auction item’s
estimated value, according to the prospectus. If a work goes
unsold, or is not paid for by the buyer, the company may not be
able to recover the money, the company said.

Because it is difficult to insure art in China, the company
does not purchase coverage for artworks put up and stored for
auction, potentially exposing it to losses, the prospectus said.